For department stores, bigger is not better: James Thomson

David Jones CEO Paul Zahra yesterday underlined the squeeze that has been put on Australia’s department stores when he delivered the company’s results for the 2011-12 financial year, a net profit of just $101.1 million, down 40% on last year.

On the one hand, poor consumer sentiment and household spending is weighing heavily on revenue. On the other hand, the failure of David Jones (and Myer for that matter) to embrace online retail means it now needs to spend big dollars to catch up. Both businesses have also increased their spending on frontline customer service staff, in order to highlight the services difference between offline and online shopping.

For both companies, this squeeze means any profit growth is likely to be minimal in the next year to two years, unless consumer spending picks up. And the fact Myer and David Jones refused to give earnings guidance for the current financial year tells you everything you need to know about the chances that cash registers will suddenly go into overdrive.

With revenue falling and costs rising, Zahra and his Myer counterpart Bernie Brookes need to look at other ways to change the department store model to not only stay relevant, but also stay profitable.

And property has become a key part of this model-changing debate.

Yesterday, Zahra said David Jones was looking at options for its property portfolio, which includes its iconic Melbourne and Sydney stores and has been valued at $612 million, although analysts believe the sale of the properties could raise as much as $1 billion.

Despite telling the market that it would cost David Jones $39 million a year to rent the stores, Zahra has made it clear he doesn’t intend to sell the stores and lease them back – although investors who have seen the value of their shares halved in the last two years probably wouldn’t mind seeing the proceeds of such a sale returned to them.

Instead, DJs says it will look at options such as subletting space to other retailers (restaurants have been mentioned in dispatches as one option) or converting empty space into office space, or adding new floors, or even building apartments atop the department stores. Presumably, David Jones will need to enter some sort of partnership or joint venture to pull this off, given its lack of property expertise.

A lot of commentators have seen Zahra’s decision to highlight the value of the property portfolio as a way of telling potential bidders for David Jones that it is more than just a retail play.

I think that’s right, but no matter who does what with the property – whether Zahra sells it or develops it, or whether someone buys David Jones and sells it and develops it – it is clear that the physical model of the department store will change as the business model is reworked.

Quite simply, stores need to be smaller and cheaper.

We can see that from David Jones’ move towards a “village” style of store focused on fashion and beauty and located in upmarket suburbs. These stores are 7,000 square metres, far smaller than the old department stores which could be up to 20,000 squares metres.

We can also see this from Myer’s new store rollouts. While Myer had tried some very small 4,000- to 6,000-square-metre stores, it is now focusing on stores that have 10,000 to 12,000 square metres of trading space. Obviously, these are cheaper to rent and staff, but can still offer the full department store’s range partly because less of the store is given over to storage and other back-end services.

Myer’s Bernie Brookes is also cutting his property costs by leaning on landlords – he said last week one landlord had dropped a store’s rent by 50% and cuts of 20% are typical.

Reducing property costs is obviously crucial when you are fighting, like Paul Zahra and Bernie Brookes.

But is it enough? Making department stores smaller and cheaper won’t solve the question of whether the model of being all things to all people (or at least lots of things to lots of people) works in a world where being specialised and cheap is everything.

Myer and DJs have a lot of reworking ahead.

James Thomson is a former editor of BRW’s Rich 200 and the publisher of SmartCompany and Property Observer.

This article originally appeared on SmartCompany